On the Effects of Strategic Alliances on Partners' Output Jong-Hun Park Department of Economics and Finance City University of Hong Kong Tat Chee Avenue, Kowloon, Hong Kong Anming Zhang Department of Economics and Finance City University of Hong Kong Tat Chee Avenue, Kowloon, Hong Kong and Department of Economics University of Victoria Victoria, B.C., V8W 3P5, Canada April 1998 JEL Classification No.: L93, L13, LS1 Key Words: Strategic Alliance, North Atlantic markets, Traffic Changes Abstract: This paper analyzes the effects of airline alliances on alliance partmers' outputs. A theoretical model of an airline alliance is developed, and an empirical analysis is then conducted using panel data of four major alliances in North Atlantic markets. It is found that most of the partners have greater traffic increases on their alliance routes than those on their non-alliance routes, supporting a hypothesis derived from the theoretical model. Acknowledgement: We thank Jim Brander, Ken Button, Martin Dresner, Ira Horowitz, Tae um, Tom Ross, and Ken Small for their very helpful comments and encouragement, Financial support from the Social Sciences and Humanities Research Council of Canada (SSHRC) and the Research Grant Council of Hong Kong is gratefully acknowledgedOn the Effects of Airline Alliances on Partners' Traffic Abstract This paper analyzes the effects of airline alliances on alliance partners’ outputs. A theoretical model of an airline alliance is developed, and an empirical analysis is then conducted using panel data of four major alliances in North Atlantic markets. It is found that most of the partners have greater traffic increases on their alliance routes than those on their non-alliance routes, supporting a hypothesis derived from the theoretical model.1, INTRODUCTION ‘The airline industry is undergoing major structural changes throughout the world. Major carriers have sought to build global networks to attract more passengers from all over the world, as passengers generally prefer airlines serving a large number of points to ones serving a smaller number of points.’ This consumer preference has induced airlines to establish global airline networks. It is almost impossible, however, for a single airline to create a truly global network under the current bilateral air agreements and foreign ownership restrictions. ‘Thus, airlines have increasingly formed airline alliances with foreign carriers, as a means of forming global networks. As of June 1996, more than 380 alliances formed among 171 international airlines. More than ‘50 alliances have emerged yearly since 1990 (Airline Business, July 1996). Alliance partners are likely to increase their traffic on alliance routes, if the partners coordinate very well and maintain their frequencies. According to the U.S. General Accounting Office (USGAO, 1995), three major alliances (British Airways/USAir, KLM/Northwest, and Lufthansa/United Airlines) have increased their annual traffic on alliance routes as a result of their alliances. The USGAO attributed the traffic increases to (i) codesharing and block space sales agreements’ on the alliance routes and (ii) a great degree of operating and marketing integration, " Reasons for this preference include: () consumers can minimize their own cost of route planning since an airline ‘with an extensive network can serve virtually all destinations; (i) consumers caa receive higher-quality service, such as online connections, with a larger airline; and (ii) a large airline usually offers a more attractive frequent flyer program ‘than a small airline (see Tretheway and Oum, 1992, pp.17-18). 2 A codesharing agreement is a marketing agreement between two airline partuers whereby one srline's designator code is shown on fights operated by its partner airline, Codesbaring agreements allows each airline involved to provide services with its partner's fights, eventhough it does not operate its aircraft. For example, Canadian Airlioes and Qantas have a codesharing agrosment on the Vancouver Honolulu-Sydney route where Canadian serves the Vancouver-Honolulu section and Qantas serves the Fonohihi-Syéney section ofthe route. If two carriers make a block space sales agreement, cach carrier can buy a block of seats inthe other carrier's flighs and resell them to passengers. Sometimes only one carrier buys a block of seats on the otfec carrier's flights. For example, Delta (DL) and Swiscair (SR) have such anEach partner's traffic on alliance routes will likely increase more than traffic increases on non-alliance routes.’ We can think of two reasons. First, each partner tends to feed its domestic traffic onto its partner’s alliance routes, but not onto non-alliance routes. For example, British Airways (BA) provided non-stop services between ten U.S. gateway cities and London in late 1992. BA formed an alliance with USAir in January 1993. According to the February 1994 issue of the Official Airline Guides, five of the ten gateways were connected to USAir’s domestic flights originated from various U.S. interior cities: one city to Boston, three to Baltimore, eleven to Charlotte, fourteen to Philadelphia, and seven to Pittsburgh. Provided USAir has successfully fed its traffic onto BA's trans-Atlantic flights between these five gateways and London, increases in traffic on the five alliance routes are likely greater than those on the other five non-alliance routes. Second, alliance partners may re-route their domestic traffic through their alliance routes. ‘Suppose Air France and Northwest provided interline services for passengers flying from Denver to Lyon, France. However, after the KLM/Northwest alliance, the partners may re-route passengers through the Denver-Detroit-Amsterdam-Lyon route. If so, traffic on the aligned Detroit-Amsterdam route will likely increase whereas that on the non-aligned Detroit-Paris route will likely decrease. Thus, the question “Does an alliance partner increase its traffic on alliance routes more than its traffic increases on non-alliance routes?” would be more interesting than the question “Does an alliance partner increase its traffic on alliance routes?” This paper examines the effects of airline alliances on alliance partners’ outputs by agreement onthe New York-Ztich route where SR actually fies, and DL buys «block of sets from SR. > Alliance routes of an alliance are referred to as routes where the alliance partners have codesharing and/or block space sales egrecmeats, while nowalliace roules are refered to as route on andlor beyond which there is no ceordnaton between the parters such ts codesbaring andlor block space sale. 2‘comparing traffic changes on alliance routes with those on non-alliance routes. To this end, an oligopolistic model is developed, It is found that under fairly standard conditions on oligopolistic interaction, a partner's total traffic on a gateway-to-gateway alliance route would increase following an alliance. Furthermore, the traffic increase can improve the airline's profit. ‘The theoretical analysis is then followed by an empirical analysis using panel data of the North Atlantic gateway routes for the 1992-94 period, In 1994, there were 33.7 million passengers travelling on North Atlantic routes, accounting for 12.6 per cent of total international scheduled-revenue passengers that year. North Atlantic markets are the largest intercontinental routes (International Air Transport Association, 1994).* We examine traffic changes of four major alliances operating in the North Aantic markets. The four alliances are: BA/USAir, Delta/Sabena/Swissair, KLM/Northwest, and Lufthansa/United Airlines. It is found that most of the alliance partners experienced greater traffic increases on their alliance routes than those on their non-alliance routes, which is consistent with the theoretical result. The effects of airline alliances have previously been investigated elsewhere. Gellman Research Associates (GRA, 1994) measured the impact of codesharing agreements of BA/USAir and KLM/Northwest on market share and welfare using data for the first quarter of 1994. They conducted a counterfactual scenario analysis based on a model estimated using the post-alliance period only. USGAO (1995) concluded, mainly based on interviews with representatives from governments and airlines, that alliances between U.S. and foreign airlines had generated large gains for the participating carriers in terms of passengers and revenues. Oum, ef al. (1996) “ In contract, trans-Pacific traffic accounted for 6.4 per cent of the total international scheduled-revenue passengers, ‘whereas trafic Between Asia and Europe accounted for 5.2 percent. 3examined the effect of codesharing agreements on firm conduct and air fares by focusing on trans- Pacific markets, They estimated the impacts of a codesharing agreement between non-leaders on the market leader's price and passenger volume. Recently, Park and Zhang (1997) empirically investigated the effects of major alliances on air fares, passenger volume, and consumer welfare ‘on alliance routes served by the aligned carriers. What distinguishes the present paper from its predecessors is that we develop a theoretical model of an airline alliance on output changes and empirically investigate the output changes on both alliance and non-alliance routes.* ‘The paper is organized as follows: Section 2 develops a model of an alliance and derives a comparative static result on traffic changes following the alliance. Section 3 provides detailed information on the four major alliances in North Atlantic markets and describes the data used in our empirical analysis. Section 4 presents empirical results. Section 5 concludes. 2, THEORETICAL MODEL Consider a non-stop intercontinental city-pair market between gateway cities A and B, where airlines 1 and 2 provide homogenous services. Airline 3 operates in the continent beyond gateway city B, Airlines 1 and 3 form an alliance such that they feed traffic to each other via B. For example, airline 1 can provide connecting services by combining its own flights between A and B with codeshared airline 3's flights between B and C, (C, is a city in airline 3's continental network). Suppose that airline 3 links N cities (including city C) to city B after the alliance (see 5 More generally, competitive behaviour in the airline industry has been the subject of covsiderable study. Useful references inchide Abragan and Keeler (1981), Call and Keeler (1985), Bailey, ef al. (1985), Morrison and Winston (1986, 1987), Boreastein (1989, 1990), Brander and Zhang (1990, 1993), Brueckmer and Spiller (1991), Abbott and ‘Thompson (1991), Dresner and Tretheway (1992), Evans and Kessides (1993), Oum, er al. (1993), Maillebiau and Hansen (1995), aod Nero (1996), iFigure 1). For convenience of expression, city C, is referred to as “city 1,” C, as “city 2,” an so on, hereafter, Let P, be the market price of the service in market k, and Q! be the corresponding service of firm i, The inverse demand function can be written as P, = P,(Q,), where Q, = > Q; is the aggregate service in market k. Airline i's cost function on route k may be expressed as C;{(7;), which indicates its round-trip cost of carrying T, passengers on the route. Note that 7; represents total passengers carried by the airline on the route. This cost function reflects economies of traffic density and thereby satisfies C,'(T,)>0 and C"(7,)<0.* Assume that the alliance partners operate their flights at their own costs, whereas they share the revenue generating from connecting services. The profits of airlines 1 and 2 operating on the AB route can be expressed as: Mis * Qs) Oh 5: P,f04)- Ou ci{os-$0 ) a it IF = PylOss+O3)-O39- C(O3s) ® respectively, where s denotes the ratio that splits the connecting-services revenue between firm © Caves, et al. (1984) distinguish between economies of traffic density and economies of firm size. Economies of traffic density mean tbat output is expanded by increasing flight frequency within a given network, Economies of firm size imply that output is expanded by adding points to the network. Many studies have obtained the result that roughly ‘constant returns to firm size exis, whereas sizeable economics of traffic density exist up to fairy large volumes of traffic. ‘See, for example, Caves, er al. (1987) tnd Brueckner and Spiller (1994). 5Land its partner (00 and dQ/dN<0. Since Tiz=Qjs+ > Qj,, we have dTj,/dN=dQ},/aN +3> dQLJdN>0. F Proposition 1. Under the conditions of this section, airline 1's total traffic on the AB route rises as its alliance partner increases the number of cities connected onto the AB route. Itis worthwhile to mention three points for Proposition 1. First, there exists the strategic effect of the alliance on firms” outputs: the partner’s traffic increases in aligned markets, whereas its rival’s traffic decreases in the AB market. As airline 3 feeds its continental traffic onto the AB route, airline 1's average operating cost on the route declines owing to economies of traffic ? The Neumann lemma is that if R is a real square matrix and the magnitude of eigenvalues of R is less than one, then (-R)" exists and (V-R)"= SR! See, for example, Ortega and Rheinboldt (1970, p. 45). 9density. Consequently, airline 1 can increase traffic not only in market AB, but also in markets An for n = 1, 2, ..., N. On the other hand, airline 3 will decrease its AB traffic since its reaction function to airline 1's output in market AB is downward sloping. Second, airline 1's soral rraffic on the AB route will increase as its partner links more cities onto the route. In general, the partners in major alliances link their networks by connecting their hub(s) to their partner's hub(s). ‘The route between the partners’ hubs will become an intercontinental alliance route. The number of cities connected onto alliance routes will be greater than that connected onto non-alliance routes, Thus, we can conjecture that alliance partners will likely increase more traffic on alliance routes than that on non-alliance routes, ‘Third, as a consequence of the above traffic effects, airline 1's profit is likely to increase following the alliance. More specifically, St ont. «(s-7,,-ch') 0, where the first term on the right-hand side is positive because II} =Pjp"Qig<0. Thus, Tl'/dN > 0 if the second term is non-negative. ‘The non-negative second term implies that airline 1 does not earn a negative profit from the connecting traffic fed by airline 3. The profit gain to airline 1 is, therefore, essentially from the strategic effect of the alliance: an increase in N reduces the rival firm's output which in tum increases airline 1's profit. This is consistent with USGAO’s (1995) argument that alliances’ traffic and revenue gains generally come at the expense of other airlines. 103. BACKGROUND AND DATA We have shown in Proposition I that an airline's total traffic is likely to increase on a non- stop, gateway route as its partners links more cities onto the route. In the remainder of the paper, ‘we will empirically investigate this result by comparing traffic changes on alliance routes to those on non-alliance routes. 3.1 Four Major Alliances in North Atlantic Market Our empirical analysis is based on four major alliances in North Atlantic markets: BA/USAir, Delta(DL)/Sabena(SN)/Swissair(SR), KLM/Northwest(NW), and Lufthansa(LH)/ ‘United Airlines(UA). ‘These four alliances account for more than 60 per cent of the entire North Atlantic market in terms of scheduled-revenue passengers: DL plus SN, SR, and Austrian accounts for 16.5 per cent, LH/UA 15.6 per cent, BA/USAir 15.3 per cent, and KLM/NW 13 per cent (Air Transport World, 1996). BA formed an alliance with USAir on January 21, 1993. BA invested $300 million in ‘USAir, which was in poor financial condition, in exchange for 21.8 per cent control. Thanks to the investment in USAir, BA is successfully linked to USAir's domestic network, and is able to connect various U.S. interior cities to London by having USAir feed its domestic traffic onto BA's trans-Atlantic flights between U.S. gateways and London. For example, BA can codeshare flights from Phoenix to London by combining codeshared USAir flights from Phoenix to Philadelphia with its own flights from Philadelphia to London. Since this alliance involves only one-sided codesharing by BA on USAir's flights within the U.S., and all of the alliance routes are long-haul flights across the Atlantic, under its prorate agreement with USAir, BA keeps most of the resulting revenues (USGAO, 1995). ilAlthough there is no equity involvement between DL and SN, this study regards DL/SN/SR as one alliance since DL and SR made an equity swap of about 5 per cent and SR invested in SN." This alliance reduced the combined number of flights offered, in that one partner stopped flying on a particular route and bought a block of seats on the other partner's flights on the same route. For example, DL and SR have codeshared on non-stop flights from Cincinnati, ‘New York, and Atlanta to Zurich, and non-stop flights from New York to Geneva. DL continues to serve the non-stop flights between Cincinnati and Zurich, with SR reserving blocks of seats, while SR continues to serve the non-stop flights on the Atlanta-Zurich, New York-Zurich and ‘New York-Geneva routes, with DL reserving blocks of seats. KLM invested in 25 per cent of NW’s voting shares and 49 per cent of its equity as of March 1993. This alliance was the first antitrust immunity granted by the U.S. Department of ‘Transportation in November 1992, shortly after the U.S. and Netherlands signed an open-skies agreement in September 1992.° The two partners are thus able to achieve a higher level of integration without fear of legal challenges from competitors. Although each carrier's management remains separable due to foreign ownership restrictions, the carriers can closely coordinate. In particular, they have linked their networks together and as of December 31, 1994, provided codeshare flights between a total of 88 North American cities beyond NW's hubs and * DL and Austrian (OS) started a codesharing and block space arrangement on Vieana-New York in late 1994. OS is this not included as part of the DL/SN/SR alliance in this study. * im May and June 1996, LH/UA and DLISN/SR/OS, reopectively, received antitrust immunity from the U.S. Departineat of Transportation. As compered to KLM/NW’s immunity, these immunities have certain routes between the prtoer hubs tht are sill subject to antitrust laws such thatthe partnrs cannot deal with certain matters relating to certain classes of tir fares and capacity on these routes: for the LH/UA alliance, Chicago-Frankfurt, aad Washington, D.C.- Frankfurt routes are restricted; and for the DLISN/SR/OS alliance, Atlanta-Brussels, Atlanta-Zurich, and Cincinnati- Zurich routes are restricted. 1230 European, Middle Eastern, and African cities beyond KLM's hub (USGAO, 1995). A ‘comparison between the change in the number of flights before and after their alliance indicates that the number of flights offered either remained the same or increased, depending on the routes. After the alliance, for example, the same number of flights was offered on the New York- Amsterdam route, while the number of flights increased on the Minneapolis/St.Paul-Amsterdam and Washington, D.C.-Amsterdam routes. ‘The LH/UA partnership, formed on June 1, 1994, is a broad commercial alliance without equity investment. The partners have linked their networks: as of December 1994, LH codeshared on UA flights serving 25 U.S. cities beyond UA hubs, while UA codeshared on LH flights serving 30 European and Middle Eastern cities beyond LH hub. ‘They also codeshared on their flights between UA and LH hubs, Each of the LH/UA partners continues to offer the same number of flights on non-stop routes. For example, each partner provided 31 flights between Washington, D.C. and Frankfurt in July 1993 (pre-alliance) and July 1994 (post-alliance). 3.2 Data To identify North Atlantic alliance and non-alliance routes, we selected 19 North American, and 12 European, gateway cities. Among the routes from the combination of these cities, the four major alliances described above were formed on 21 routes during the 1993-1994 period. Two routes (Toronto-Paris and Montreal-Paris) were eliminated due to lack of data.'° 2° One of the partners on these two routes did not report its passengers carried for some of the years under ‘consideration. It is noted that these two routes are related with simple route-by-route alliances and that the number of ‘observations is insufficient to distinguish the effects of major strategic alliances from those of the simple route-by-route alliances. 13We then randomly selected non-alliance routes for each alliance under consideration, matching the number of non-alliance routes to that of alliance routes. Table 1 shows North Atlantic alliance and non-alliance routes selected for the study. Data associated with alliances are mainly taken from the Official Airline Guides (OAG): Worldwide Edition. Airlines joining alliances are identified by the symbol "s" and their flight numbers in the OAG. The February and July issues for the 1990-94 period were used to check whether a particular alliance was still ongoing. To clarify unclear cases, we also used other sources including the Airline Business (1994), International Civil Aviation Organization (ICAO) Jourrial (1990-94), and U.S. General Accounting Office (1995). ‘We gathered each airline's total passenger volume between gateway cities from the ICAO's Traffic By Flight Stage. Total passenger volume includes connecting passenger volume as well as non-stop passenger volume on a route. Since the four major alliances were formed in either 1993 or 1994, traffic changes in years 1993 and 1994 were computed for each of the alliance partners for each of the sample routes. 4, EMPIRICAL RESULTS Table 2 shows overall traffic changes on the alliance and non-alliance routes. The first column (AQ) shows average traffic changes during the 1993-94 period. ‘The number in the second column represents the total number of passengers carried by each alliance partner in 1992. The last column indicates the percentage of traffic change from the traffic of 1992. According to Table 2, traffic on the alliance routes generally increased more than that on the non-alliance 14routes. For example, BA increased traffic by an average of 6.8 per cent on its alliance routes, as compared to an average increase of 1.1 per cent on its non-alliance routes. DL and SN increased their combined traffic by an average of 30.3 per cent on their alliance routes, as compared to an average increase of 11.1 per cent on their non-alliance routes."' Similar results are observed in the KLM/NW and LH/UA alliance cases. ‘The overall traffic changes shown in Table 2 appear to be consistent with Proposition 1. Because of the nature of panel data, however, route-specific and year-specific effects need to be controlled in order to compare traffic changes on alliance routes with those on non-alliance routes. To do so, we conduct the following regression: AQ, = B,PINA + B,(Qpr You) +L BRTE, where AQ=Q,-Q,.; PTNA = Q,, if an airline’s route is an alliance route at year t, zero otherwise; Y5, = 1 for year 1994, zero otherwise; and RTE, =1 for route j, zero otherwise. Here 8, represents the effect of an alliance on the partner's traffic and shows the average percentage of traffic changes on the alliance routes, after taking into account traffic changes on the non- alliance routes. , represents traffic changes between 1993 and 1994. For example, an estimate of 0.01 for 6, means that traffic increases by one per cent in 1994 over the level in 1992. Estimation results are provided in Table 3. The results for each alliance are reported on each column. Most coefficients of the alliance partner variables are estimated as positive and ™ The avernge increase of 11.1 per cent on the non-alliance routes can be calculated by dividing the total AQ and {otal Q, for DL and SN. 15statistically significant, supporting Proposition 1, ‘The coefficient of BAA is estimated as 0.083 and highly significant. Due to USAir's traffic feeding, BA was able to increase traffic by 8.3 per ‘cent more on its alliance routes than traffic increases on its non-alliance routes, during the post- alliance period, The coefficients for SNA and SRA are estimated as positive and significant. It implies that due to the DL/SN/SR alliance, SN and SR increased traffic on their alliance routes by 39 per cent more and 28 per cent more, respectively, than traffic increases on their non-alliance routes, during the post-alliance period, The estimated coefficient for DLA is positive, but statistically insignificant. In fact, DL took advantage of its alliance with SN and SR by increasing its traffic on the alliance routes more than traffic increases on the non-alliance routes (see Table 2). However, DL stopped operating on some North Atlantic routes in 1994, decreasing the growth rate by 7.6 per cent during the post-alliance period (Intemational Air Transport Association, 1994). ‘These two offsetting effects may cause the coefficient of DLA to be insignificant. The coefficient of NWA is very high and significant. NW re-routed its traffic on major North Atlantic routes between its hubs, Boston and Minneapolis/St, Paul, and European cities since forming an alliance with KLM. Due to the re-routing, for example, traffic between Boston and Amsterdam increased by an average of 35 per cent of the 1992 traffic during the 1993-94 period, while traffic between Boston and Frankfurt, London, and Paris decreased by 9 per cent, 13 per cent, and 3 per cent, respectively, of the 1992 traffic during the post-alliance period. By reflecting NW's traffic decreases on the non-alliance routes, its traffic is estimated to increase by more than 100 per cent over the previous year's traffic. ‘The coefficient of LHA arid UAA are estimated to increase traffic by 10 per cent and 8 per 16cent, respectively, on their alliance routes during the post-alliance period, after taking into account traffic changes on their non-alliance routes. Unlike the other alliances, this alliance generates relatively balanced traffic increases for the partners. 5, CONCLUDING REMARKS ‘This paper has examined the effects of airline alliances on partners’ traffic. A theoretical model is developed, and an empirical analysis is then conducted to estimate alliance partners’ traffic changes on alliance routes while taking their traffic changes on non-alliance routes into consideration. The theoretical model finds that under fairly standard conditions on oligopolistic interaction, following an alliance, a partner's total traffic on a gateway-to-gateway alliance route ‘would increase and thus the partner's profit would likely increase. For the empirical analysis, we vuse panel data consisting of the four major alliances operating on North Atlantic non-stop routes between gateway cities, for the 1992-94 period. The empirical analysis shows that most of the partners have greater traffic increases on their alliance routes than those on their non-alliance routes, Among others, BA was able to increase traffic by 8.3 per cent more on its alliance routes than on its non-alliance routes, during the post-alliance period. Furthermore, LH/UA increased traffic by 10 per cent more and 8 per cent more, respectively, on their alliance routes than on their non-alliance routes, during the post-alliance period. The empirical results are largely consistent with a hypothesis derived from the theoretical model. 17REFERENCES Abbot, K. and Thompson, D. (1991), "De-regulating European aviation: The impact of bilateral liberalisation," International Journal of Industrial Organization, Vol. 9, 125-140. Abragan, M. and Keeler, T.E. (1981), “Market Structure, Pricing and Service Quality in the Airline Industry Under Deregulation," In W. Sichel and T. Gies (eds.): Application of ‘Economic Principles in Public Utility Industries, Michigan Business Studies, Vol. 2, 103- 120. Baily, E.E., Graham, D.R. and Kaplan, D.P. (1985), Deregulation and Theory of Contestable Markets, Cambridge, Mass., MIT press. Borenstein, S. 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Daughety (ed.): Analytical Studies in Transport Economics, Cambridge: CUP, Caves, D.W., Christensen, L.R. and Tretheway, M.W. (1984), "Economies of density versus economies of scale: Why trunk and local service airline costs differ," Rand Ioumal of Economics, Vol. 15, 471-489. Caves, D.W., Christensen, L.R., Tretheway, M.W., and Windle, R. (1987), "An Assessment of the Efficiency Effects of U.S. Airline Deregulation Via an Intemational Comparison," in E.E. Bailey (ed.), Public Regulation: New Perspectives on Institutions and Policies, 18MIT Press, Cambridge. Dresner, M. and Tretheway, M.W. (1992), “Modelling and Testing the Effect of Market Structure on Price: The Case of International Air Transport,” Joumal_of Transpart Economics and Policy, Vol. 26, 171-184. Evans, W. and Kessides, IN. (1993), "Localized Market Power in the U.S. Airline Industry," Review of Economics and Statistics, Vol. 75, 173-202 International Civil Aviation Organization, ICAO Journal, various issues of 1990-1994, Montreal, ICAO. International Civil Aviation Organization, Traffic By Flight Stage, 1990-1994, Montreal, ICAO. International Air Transport Association, North Atlantic Passenger Traffic Report, 1994, Hounslow, Middx, IATA. Maillebiau, E. and Hansen, M. (1995), "Demand and Consumer Welfare Impacts of International Airline Liberalisation: The Case of the North AUantic," aural af Transport Economics and Policy, Vol. 29, 115-136. Morrison, S.A. and Winston, C. (1986), The Economic Effects of Airline Deregulation, Washington, D.C., The Brookings Institution. Morrison, S.A. and Winston, C. (1987), "Empirical Implications and Tests of the Contestability Hypothesis," Journal of Law and Economics, Vol. 30, 53-56. Nero, G. (1996), "A Structural Model of Intra European Union Duopoly Airline Competition,” Journal of Transport Economics and Policy, Vol. 30, 137-155. OAG: Worldwide Edition, various issues of 1990-1994, Illinois, Official Airline Guides. Ortega, J.M. and Rheinboldt, W.C. (1970), Iterative Solution of Nonlinear Equations in Several ‘Variables, Academic Press, New York. Oum, T.H., Park, J.-H. and Zhang, A. (1996), “The Effects of Airline Codesharing Agreements ‘on Firm Conduct and International Air Fares,” Iournal_of Transport Economics and Policy, Vol. 30, 187-202. Oum, T.H., Zhang, A. and Zhang Y. (1993), “Inter-Firm Rivalry and Firm-Specific Price Elasticities in Deregulated Airline Markets," lournal af Transport Economics and Policy, Vol. 27, 171-192. 19Park, J.-H. and Zhang, A. (1997), “An Empirical Analysis of Global Airline Alliances: Cases in North Atlantic Markets," Mimeo. Shapiro, C. (1989), “Theories of Oligopoly Behavior," in R. Schmalensee and R.D. Willig (eds.): Handhook of Industrial Organization, New York: North-Holland. ‘Tretheway, M.W. and Oum, T.H. (1992), Airline Economics: Foundation for Strategy and Policy, The Centre for Transportation Studies, University of British Columbia. U.S. Department of Transportation (1994), "A Study of International Airline Codesharing,” Gellman Research Associates, Inc., December 1994. U.S. General Accounting Office (1995), “Airline Alliances Produce Benefits, but Effect on Competition is Uncertain," GAO/RCED-95-99, April 1995. Zhang, A. and Zhang, Y. (1996), "Stability of a Cournot-Nash Equilibrium: The multiproduct Journal of Mathematical Economics, Vol. 26, 441-462. 20FIGURE 1. Linkage between Airlines 1 and 3 21TABLE 1. Selected North Atlantic Alliance Routes vs. Non-alliance Routes Alliance NORTH ATLANTIC ROUTES BA/USAir ATL-LON, BOS-LON, BWI-LON, DAL-LON, LAX-LON, NYC-LON, ORL-LON, PHL-LON, SEA-LON, WAS-LON DL/SN/SR ATL-LON, ATL-ZRH, BOS-BRU, BOS-ZRH, CHI-BRU, LAX-FRA, LAX-GNV, LAX-ZRH, MIA-FRA, NYC-FRA, NYC-ROM, NYC-ZRH KLM/NW BOS-AMS, BOS-FRA, BOS-LON, BOS-PAR, DET-AMS, DET-PAR, MSP-AMS, NYC-AMS, WAS-AMS, YMX-AMS, ‘YYZ-aMS 1H/UA, BOS-FRA, MIA-FRA, ‘WAS-LON, CHI-PAR, DET-FRA, LAX-FRA, NYC-LON, SEA-LON, SFO-PAR, Wotes) 1. The underlined routes are alliance routes. 2. City codes AMS: Amsterdam, ATL: Atlanta, BOS: Boston, BWI: Baltimore, CHI: Chicago, CPH: Copenhagen, CVG: Cincinnati, DAL: Dallas/Ft.Worth, DET: Detroit, FRA: Frankfurt, GNV: Geneva, LAX: Los Angeles, LON: London, MIA: Miami, MSP: Minneapolis/St.Paul, NYC: New York, ORL: Orlando, PAR: Paris, PHL: Philadelphia, ROM: Rome, SEA: Seattle, SFO: San Francisco, WAS: Washington, D.C.,YMX: Montreal, YVR: Vancouver, YYZ: Toronto, ZRH: Zurich 2TABLE 2. Traffic Changes Between Alliance and Non-Alliance Routes Alliance AQ Qsz AQ/Qs2 1.BA/USAir Alliance routes 59,890 879,722 0.068 Non-alliance routes 3,982 354,766 0.022 TOTAL 63,872 1/234, 486 0.052 2.DL/SN/SR Alliance routes DLtSN 21,659 72,469 0.303 DL+SR 18,975 118,592 0.160 Non-alliance routes DL 32,287 354,116 0.092 SN 21,374 40,725 0.279 SR 4,607 182,193 0.025 TOTAL 88,902 767,095 0.116 3.KL/NH Alliance routes RL 38,843 306, 663 0.127 MW 80,628 120,626 0.668 Non-alliance routes xL 6,863 215,202 0.032 Ww -21,127 387,679 -0.054 TOTAL 105/207 7,030,170 4.LH/UA Alliance routes pa 19,270 175,007 0.110 vA 6,138 139,841 0.044 Non-alliance routes LH -6,541 256,692 -0.025 UA 1,679 762,801 0.002 TOTAL 20,546 1,334,341 0.015 23,TABLE 3. Traffic increase on Alliance routes vs. That on Non-alliance routes 0.174 (0.97) 0.390 @.81) ¢ 0.279 @.72)¢ 0.009 (0.23) 1.045 2.47) b 0.100 3.23) € 0.076 (2.20) b Qn * Yo 0.002 (0.09) 0.082 (2.43) b 0.063 (2.31) b 0.093 (8.03) ¢ ATL-AMS * ATL-BRU* ATLFRA * ATL-LON ATL-ZRE* BOS-AMS * BOS-BRU BOS-FRA BOS-LON * BOS-PAR “124.6 (-0.04) -739.9 (0.20) 19451.0 (4.4 € 3743.8 (0.90) -10275.0 (1.54) -3989.2 (1.27) 5326.0 (2.87) b 877.5 (0.23) -45696.0 (1.65) 4050.6 (1.28) -10807.0 (3.17) € 137.5 (0.04) 6830.5 8.25) € BOS-ZRH BWI-LON* (CHI-BRU CHI-FRA * CHIL-PAR 35782 (8.80) € -1837.0(-0.46) 8764.9 2.36) b 6879.5 (4.19) ¢ 5285.8 2.68) ¢ Giates) * indicates an alliance route. Number in parentheses is t-statistic. a: pvalue < 0.1, b: p-value < 0.05, ¢: pvalue < 0.01 24TABLE 3. (Continued) Variables BA/USAir DLISNISR, KLMINW um | (CHL-ZRE CVG-ZRH* DAL-LON DET-AMS * DET-FRA 734.4 (0.19) ‘5155.0 (0.90) 975.2 (0.33) 37685.0 (9.72) 3625.0 (1.11), 7825.6 (2.83) © DET-PAR LAXFRA LAX-GNV LAX-LON * LAX-ZRH, 2098.8 (0.66) 13607 (3.63) ¢ 4157.8 (41.12) 8482.7 (2.75) 2383.2 (0.64) 8349.2 (4.13) ¢ “719.9 (0.36) ‘MIAFRA ‘MSP-AMS * NYC-AMS * NYC-BRU* NYC-CPH 7263.5 (4.38) -1780.7 (0.07) 4498.9 (1.07) -13622.0 (2.74) ¢ 12725.0 3.42) € 6352.7 G.14) ¢ NYC-FRA NYC-LON * NYC-ROM NYC-ZRH * ORL-LON ~5833.5 (1.40) -14217.0 (3.66) € 1994.8 (0.52) “14095 (-2.13) b 2737.4 (0.92) 25808.0 (12.1) ¢ 1908.0 6.5) ¢ PHL-LON* ‘SEA-LON ‘SFO-PAR ‘WAS-AMS * WAS-FRA * 3053.5 (0.90) 608.2 (0.21) 9197.7 2.07) b 4916.2 2.51) b 6199.0 G.17)¢ 2124.7 (1.28) ‘WAS-LON WAS PAR Y¥MX-AMS ‘YVR-AMS YY¥Z-AMS 1413.6 (0.42) 4583.4 (1.42) 4187.8 (1.36) 13200.0 3.92) ¢ {6055.9 (3.03) ¢ Notes) * indicates an alliance route. [Number in parentheses is t-statistic. a: pvalue < 0.1, b: p-value < 0.05, c: p-value < 0.01 25